The CPI inflation rate is finally falling; The good and bad news for the Dow Jones

The CPI inflation rate has finally passed its peak, we’ll know for sure on Wednesday morning. Drop in gas prices, retail discounts, return of online deflation and a drop in shipping costs suggest there will be a fairly quick retreat from June’s 40-year high of 9.1%.


The combination of a peak in inflation and a drop in the peak of the Federal Reserve has been an antidote to the bear market. After strong rallies since mid-June, the Dow Jones and S&P 500 have broken out of bear market territory. Only the Nasdaq’s loss is still above the 20% bear market threshold.

But Friday’s strong jobs report has dampened the bullishness. Can the fall in the inflation rate give it a new boost?

CPI inflation rate forecast

Wall Street economists expect the consumer price index to rise 0.2% in July, following June’s 1.3% increase. The annual inflation rate is seen to decrease from 9.1% to 8.7%.

However, core inflation, which excludes food and energy prices, is not expected to show much moderation. The core CPI rose 0.5% in the month, following June’s 0.7% increase. The core inflation rate is expected to return to 6.1% from 5.9%, with rising housing costs a major contributor.

Expectations of the inflation rate

Still, it’s not just headline inflation that’s falling, but inflation expectations as well. The New York Federal Reserve’s survey of consumer expectations released on Monday found that the average expectation of inflation over three years fell to 3.2% from 3.6% the previous month . Five-year inflation expectations were cut from 2.8% to 2.3%.

The reason policymakers care is that inflation seeps into consumer psychology, affecting purchasing behavior and even negotiating wage increases. The more entrenched inflation becomes, the harder it will be for the Fed to uproot.

With signs that consumers are becoming less concerned about the prospect of permanently high inflation, the Fed will feel less need to accelerate rate hikes.

No more Fed Forward guidance

Fed Chairman Jerome Powell already said on July 27 that policymakers were suspending forward guidance. They will go meeting by meeting, deciding the appropriate policy settings based on the latest data. What has changed? As the Fed’s key interest rate nears neutral and heads into tightening territory, policymakers will tend to move more gradually. This is especially the case as signs of economic weakness have spread from housing to consumer spending and business fixed investment.

The Fed’s next rate hike: 50 or 75 basis points?

For now, Wall Street sees it 67.5% chance of another 75 basis point rate hike when the Fed will adjust its policy on September 21. Those odds soared after Friday’s unexpectedly warm jobs report.

Here’s the good news: the odds of a bigger move may be overblown.

The decision to hike 75 basis points at each of the last two Fed meetings “was driven by rising inflation expectations, which have since declined decisively,” the financial economist wrote chief of Jefferies, Aneta Markowska.

Also, we will need to produce a second soft CPI report before the Fed meeting in mid-September. At this point, Markowska sees the potential for August prices to contract 0.2% from July amid a further drop in energy prices.

The Fed’s focus is back on core inflation

When oil prices were still rising, Powell appeared to downplay the Fed’s usual focus on core prices, saying the concept was unfamiliar to households struggling with inflation.

Now that oil prices are falling, Powell is turning his focus back to underlying inflation. “Core inflation is a better predictor of inflation going forward,” Powell said at his press conference on July 27.

“Core inflation should also ease in the coming months given the overwhelming evidence of easing supply chain pressures,” Markowska wrote. But he expects core inflation to “remain sticky, supported by tight housing and labor markets.”

Non-energy services, or basic services, account for 57% of consumer budgets, according to the Labor Department, led by housing and health care. The inflation rate for these categories reached 5.5%, the highest in 30 years, in June.

Recession climate deepens for US economy: IBD/TIPP

Report Two economic paths after employment

The Dow Jones’ initial reaction to the July jobs report was muted, in part because markets were expecting soft CPI inflation data this week. However, in its wake, the expected Fed pivot seems more distant. What is clear from the report is that the labor market is as tight as a drum. If hiring is really as strong as the 528,000 job gain appears to be, then the Fed has its work cut out for it.

Economists at Deutsche Bank say the jobs figures “reinforce our previous consensus call for a terminal fed funds rate of 4.1%, which the market now appears to be waking up to.”

The other possibility is that the employment data overstates the strength of the labor market. The Labor Department’s survey of households shows that the number of people working has fallen by 168,000 over the past four months, although the survey of employers shows 1.68 million new jobs.

But even if the labor market is weaker than it appears, there is no reason to doubt the jobs report’s indication that the labor market is extremely tight. If this is the case, wage pressures and underlying inflation may dissipate more slowly. The Fed may stop tightening sooner, but a turn toward rate cuts and an end to the tightening of the balance sheet may take some time.

Dow Jones rally on hold?

After Friday’s jobs report, financial markets are pricing in a rate hike of more than a quarter point to a range of 3.5% to 3.75% early next year . By mid-2023, financial market odds are leaning towards easier policy. But a higher terminal federal funds rate makes the path to a soft landing even trickier. It suggests the Fed is more likely to overreach, triggering a recession and falling earnings.

On Tuesday, the Dow Jones fell 0.2% and the S&P 500 fell 0.4%. The Nasdaq, which had outperformed in recent weeks, returned 1.2%.

Having staged a strong rally, it may take some soft core inflation readings to rekindle the bulls.


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About the Author: Chaz Cutler

My name is Chasity. I love to follow the stock market and financial news!